Network effects are the Holy Grail for Internet startups looking for venture-scale returns. On a platform with network effects, the value to a user increases as more users use it. Facebook, Twitter, LinkedIn, YouTube, Skype, and many others benefit from this dynamic.
2012 will go down as the year when a billion people were connected over a single platform for the first time in history. But as online networks grow to a size never seen before, many question their sustainability and believe that they are becoming too large to be useful.
To explore the future of online networks, it’s important to note how network effects correlate with value and the factors that make these network effects work in reverse.
There is a strong correlation between scale and value in businesses with network effects. Greater scale leads to greater value for users, which in turn attracts other users and further increases scale. This rich-become-richer dynamic allows networks to scale rapidly once network effects set in.
There are three sources of value created on networks:
Networks allow users to discover and/or connect with other users. As more users join the network, there is greater value for every individual user. Skype and WhatsApp become more useful as a user’s connections increase. Match.com and LinkedIn become more useful as more users come on board. ...